Chapter 03 – Securities Markets
CHAPTER 03
SECURITIES MARKETS
1. An IPO is the first time a formerly privately-owned company sells stock to the
2. The effective price paid or received for a stock includes items such as bid-ask
3. The primary market is the market where newly-issued securities are sold, while
4. The primary source of income for a securities dealer is the bid-ask spread. This is
5. When a firm is a willing buyer of securities and wishes to avoid the extensive
6. A stop order is a trade is not to be executed unless stock hits a price limit. The
stop-loss is used to limit losses when prices are falling. An order specifying a
7. Many large investors seek anonymity for fear that their intentions will become
9. Margin is a type of leverage that allows investors to post only a portion of the
10. a. A market order has price uncertainty but not execution uncertainty.
Chapter 03 – Securities Markets
12. a. In principle, potential losses are unbounded, growing directly with
increases in the price of IBX.
13. Answers to this problem will vary.
14. a. In addition to the explicit fees of $60,000, we should also take into
account the implicit cost incurred to DRK from the underpricing in the
b. No. The underwriters do not capture the part of the costs corresponding to
the underpricing. However, the underpricing may be a rational marketing
strategy to attract and retain long-term relationships with their investors.
Without it, the underwriters would need to spend more resources in order
15. a. The stock is purchased for $40 300 shares = $12,000.
b. If the share price falls to $30, then the value of the stock falls to $9,000.
By the end of the year, the amount of the loan owed to the broker grows
to:
Chapter 03 – Securities Markets
c. Rate of return = Ending equity in account － Initial equity in account
Initial equity in account
16. a. The initial margin was: $40 x 1,000 0.50 = $20,000.
As a result of the $10 increase in the stock price, Old Economy Traders
loses: $10 1,000 shares = $10,000.
b. Margin on short position = Equity
Value of shares owed
c. The rate of return = Ending equity － Initial equity
Initial equity
17. a. The market-buy order will be filled at $50.25, the best price of limit-sell
orders in the book.
b. The next market-buy order will be filled at $51.50, the next-best limit-sell
Chapter 03 – Securities Markets
18. a. Your initial investment is the sum of $5,000 in equity and $5,000 from
borrowing, which enables you to buy 200 shares of Telecom stock:
Initial investment
Stock price = $10,000
$50 = 200 shares
b. The value of the 200 shares is 200P. Equity is (200P – $5,000), and the
required margin is 30%.
19. a. Initial margin is 50% of $5,000, which is $2,500.
b. Total assets are $7,500 ($5,000 from the sale of the stock and $2,500 put
up for margin). Liabilities are 100P. Therefore, net worth is ($7,500 –
100P).
20. The broker is instructed to attempt to sell your Marriott stock as soon as the
Marriott stock trades at a bid price of $68 or less. Here, the broker will attempt to
21. a. The trade will be executed at $55.50.
Chapter 03 – Securities Markets
22. a. You will not receive a margin call. You invest in 1,000 shares of Ixnay at
$40 per share with $20,000 in equity and $20,000 from borrowing. At $35
per share, the value of the stock becomes $35,000. Therefore, the equity
decreases to $15,000:
23. The proceeds from the short sale (net of commission) were:
($21 100) – $50 = $2,050.
A dividend payment of $300 was withdrawn from the account. Covering the
short sale at $15 per share costs (including commission): $1500 + $50 = $1550.
24. The total cost of the purchase is: $40 500 = $20,000.
Investing $15,000 from your own funds and borrowing $5,000 from the broker,
you start the margin account with the net worth of $15,000.
a.
(i) Net worth increases to: ($44 500) – $5,000 = $17,000
Percentage gain = ($17,000 – $15,000)/$15,000 = 0.1333 = 13.33%
(ii) With price unchanged, net worth is unchanged.
Percentage gain = zero
b. The value of the 500 shares is 500P. Equity is (500P – $5,000). You will
receive a margin call when:
c. The value of the 500 shares is 500P. But now you have borrowed $10,000
instead of $5,000. Therefore, equity is (500P – $10,000). You will receive
a margin call when:
Chapter 03 – Securities Markets
d. By the end of the year, the amount of the loan owed to the broker grows
to:
The equity in your account is (500P – $5,400). Initial equity was $15,000.
Therefore, the rate of return after one year is as follows:
(i) (500 $44)－$5,400－ $15,000
$15,000 = 0.1067 = 10.67%
For example, when the stock price rises from $40 to $44, the percentage
change in price is 10% (0.10), while the percentage gain for the investor
e. The value of the 500 shares is 500P. Equity is (500P – $5,400). I will
receive a margin call when:
25. a. Given the $15,000 invested funds and assuming the gain or loss on the
short position is (–500 P), we can calculate the rate of return using the
following formula:
Chapter 03 – Securities Markets
Total assets on margin are the sum of the initial margin and the proceeds
from the sale of the stock:
b. With a $1 dividend, the short position must now pay on the borrowed
shares: ($1/share 500 shares) = $500. Rate of return is now:
[(–500 P) – 500]/15,000
CFA 2